Amid 2021’s record-breaking funding activity, it wasn’t uncommon to see startups raise rounds composed of numerous small checks from a large number of firms and angel investors. But now that said companies are looking to raise extension financing, they’re realizing that more investors doesn’t always mean more future money.
Last year, FOMO was running high, and investors were doing seemingly everything to get into rounds: taking a secondary stake instead of a primary, forgoing a board seat, writing a tiny check just to get into a hot deal.
Many founders leaned into this, and how can you blame them? Investors wanted to put more money into their companies, and each investor brings their own value-add and network to the table. In theory, that looks like a good thing. But, the pros of raising party rounds dry up quickly when the market turns — and a lot of companies are starting to realize that.
Dan Scheinman, an angel investor who has backed companies including Zoom, Arista Networks and CyCognito, said that lately he’s seen an uptick in founders reaching out to him to see if he’ll invest in their bridge financing — not that they would ever call it that. What stood out to him, though, was that many of these startups had numerous well-known firms and so-called Silicon Valley celebrity angels on the cap table who weren’t following on.
“It is clear that there is a pattern where some of these rounds were clearly party rounds and people were clearly joining in because other investors were,” Scheinman said. “They work great and fabulous when things are going well, but when they don’t, sometimes no one feels responsible for the company.”
Scheinman said that outreach has spiked in recent weeks, and it isn’t just coming from “bad” companies that are struggling to raise in general. He added that many of the startups that reach out have credible business models and ideas, but he found it odd that they would tout who was on their cap table as a reason Scheinman should invest — even though those investors weren’t.
Dane Patterson, a partner at Goodwin Procter, said that while he hasn’t noticed a jump in this dynamic lately — although he added that, as a lawyer, he may come into the deal process after these conversations — he always counsels his clients against taking on too many investors for this exact reason.
“When it is all up and to the right, it’s not an issue, but when the company is in a tough spot, there is no one there that feels the obligation to step up,” Patterson said. “No one wants to take that responsibility in this market if they aren’t a lead investor who might have more skin in the game.”
While Patterson might not be seeing it, he said he isn’t surprised this is happening again in today’s market. Multiple other investors confirmed on Twitter that they are witnessing it, too.
Elizabeth Yin, a general partner at Hustle Fund, said this dynamic is just one of the many roadblocks founders are facing in this more challenging fundraising environment.
“I mean, when you think about it, startups who raise from, you know, dozens of people, small angels, small funds, etc., no one really feels like they have that much skin in the game,” Yin said.
It’s important to remember that not all of these angels and funds were set up to make these kinds of follow-on investments, which makes this dynamic more complicated. Founders may find themselves in a bind that their existing investors couldn’t solve even if they wanted to.
In that case, Yin said that these backers can at least help their existing portfolio companies secure other financing. Yin speaks from experience: Hustle Fund’s pre-seed focus prevents it from pouring additional money into all of the portfolio companies that need it but helping secure the additional funds has become a bigger use of her time.
But it is hard to know if this trend will actually end heading into next year. While many people raised in this manner because the market was hot, they may find themselves having to raise party rounds again as firms cut their check sizes and look to take smaller stakes while companies still need the same amount of cash.
It’s unclear if party rounds are over, but the fun sure is.